Interest Free Payments…are they a bad idea?
Just like most of you, I peruse a lot of personal finance blogs. Today I came across one that posed an idea that got me thinking.
Not Made of Money posted a nice piece about not buying stuff with a payment mentality.
I left a comment saying that I totally agreed that its a great idea to get rid of payments. But what about interest free payments? I used an example of saving enough money for an $800 item then being offered interest free financing at the time of purchase.
Would you take the offer or pay in full?
In my pre-Happy Rock days I always took the offer.
When my wife’s Grandfather passed away, an estate sale was held. The proceeds were then divided up and each grandchild got a check for $600. At the same time, we were looking at a headboard and foot-board set for our bed that, wouldn’t you know it, cost $600.
When we went to purchase the set, we took advantage of 6 months interest free plan on purchases over $500. I then paid $100 a month for 6 months and that was that.
Another example was when we built a fence. We were going to use our tax rebate to buy the materials needed to build a picket fence. At the store I noticed that if I signed up for a store credit card not only would I save 2% on the purchase but I’d also get 12 months interest free financing.
So I signed up for the card and paid for my fence over the course of the next 12 months instead of all in one day.
But would I make this same decision today?
I understand there are some pitfalls of the interest free game. In my examples there were minimum payments to be made and if I was ever late I’d have to pay a fee and lose the “interest free” time allotment and have the added cost of interest to deal with. Luckily this never was an issue for me, but I could easily see how this could happen.
But I could also think of a couple of advantages to using interest free credit as well.
Lets say you get a longer period (we once had 30 months “interest free” to pay off our bed) combined with a larger purchase price. If you already had the money saved up, couldn’t you use this time to earn a little extra interest while you made payments? I know it wouldn’t add up to be much, but I just showed how the little things can make a difference so maybe for some it WOULD be worth it.
The other advantage that came to mind was the piece of mind that the added cash flow could offer someone. The money may be already spoken for, but it can feel good seeing the higher balance.
Even though I’m now The Debt Defier, I think I might still use interest free when it’s presented (Assuming of course that I’d already have saved the amount needed for the purchase). But with my current situation, I don’t think I’ll be making any large purchases any time soon.
But lets say I was going to be making a large purchase soon, would I be stupid to even think about using an interest free option? Are there some pitfalls that I didn’t think of that are associated with this idea? Or perhaps a lot of you take advantage of these kinds of promotions and I’m just late to the party?
As always, I appreciate getting your feedback on this stuff so please let me know what you would do.
Until next time
-DD
Principles in Action #2 : Accountability and Friends Can Save Your Finances
Total Money Makeover – The Snowball Starts
Interest free payments are still debt. Yes debt with interest is were most of the financial pain comes in, but there is still the psychological side of debt to consider. Payments weigh you down and limit you options. You lose cash flow. If you were to lose your income, or don’t have the discipline that you thought you had to keep the money in the bank . Financially, speaking if you make one mistake with interest free stuff, it can waste tons of money in fees and back interest. These type of lending situations are not friendly local banks they tend to be notoriously greedy, gauging, and not out for your interests at all.
Plus the stress of a monthly payment that you can’t miss or make a mistake on is add financial stress that erodes financial simplicity and its benefits.
I would also argue that it in most cases makes it harder to resist credit the next time. Credit tends to fuel our primal materialistic nature and the more we give that side of us fuel the harder it is to keep down.
My final point is that you aren’t going to get rich with credit card rewards and small interest free loans. They do have small financial benefits, until things go wrong. In most cases I would argue that there are a lot more places that we can put our financial and mental energy that will provide much better returns.
Good discussion DD. I think it gets to the some of the core principles why ditching day buys you much much more than just getting rid of interest and debt.
Debt is debt whether you’re paying interest on it or not. The fact is, if some emergency situation arises, you could very easily be forced to spend the money earmarked for some kind of no-interest/no-payments purchase. Then, when it comes time to pay the piper, you’re not only in the hole, but then crushing interest usually kicks in.
You (and I) need to develop a cash-only mentality. If I can’t buy it outright, then I need to wait or find a less expensive (maybe temporary) alternative.
In “The Total Money Makeover” Ramsey makes a great point. If you are buying, furniture and you start flashing some bills, there is a good chance that the salesman will attempt to work a deal. If you walk in looking to finance. There will be no deal made. You lose.
To piggy-back on Ed’s point: Ramsey likes to say that “90 days same as cash is NOT the same as cash.”
I’ve done this (no-interest financing) a lot in the past and luckily never got burned. I was also paranoid about missing a payment and getting charged all the back interest. So I would always set up payments to make sure I paid it off well in advance.
So, look at that right there – I could have paid cash, owned the item outright, and maybe got a discount as Ed mentioned. What I did instead was used the “free” financing and then spent the next few months running the risk of having to pay the interest while being stressed about screwing up the payments. To me, that was not worth the few dollars in interest I earned on that money.
I like the Dave Ramsey mentality of “90 days same as cash is not same as cash”, but I don’t always follow it. Much like the author, if there is something that I’m purchasing anyway and I can get it at that time on one of these same as cash plans, I usually do it. However, I like to set up automatic payments on the account to pay it in full before the grace period is up.
If I have the money and I am planning on purchasing something, I don’t think I’ll go for the payment plan. I have had a few times where i forgot a payment (it wasn’t even that i didnt have the money, just forgot) and lost the perks of a certain card/payment plan.
So for me, I just need to pay the money…. though, playing the arbitrage game… if you do have the money in a 3% account or something, and setup automatic payments out of that account onto the interest free finance plan, then it may work out for you….
I smell danger in the fact that you are even considering doing it. I can say in the past I was offered a similar deal for buying carpet and the saleman was surprised when I handed over a check instead. Why not take financing? Because it is financing. When your hot water heater leaks, your dish washer breaks and your basement floods twice you won’t have the extra cash on hand to make the payments. Buy with cash then save up for the next item. Can’t go wrong that way.
I’m going to be the odd one out here and say that I like interest-free financing. When we had debt from starting our business several years ago, we transfered it to a zero percent credit card. we had to make one purchase a month and pay the bill on time, but it allowed us to take about two tears to pay off a $4000 balance. Total interest over that time was about $10 – on the new purchases.
We remodeled our kitchen in Feb this year, and put about $2100 on a Home Depot card that we opened in order to save $200 up front. From the beginning we had the money to pay it off, but we’re stretching it out over the whole year in order to keep the money earning interest as long as we can. I get email reminders to pay the bill, although we technically don’t have to pay anything until the year is up – no late fees, no interest, no payments at all for a year. We did the same thing with a computer last summer.
We rarely make big purchases and we don’t pay interest on anything except our house these days. But when we do have a large purchase that can be done with zero percent financing, we definitely consider it.
I would have to agree with frugal babe. I like interest free financing when its available and only when it is a large purchase and I have the money already saved up. That way I can keep gaining interest on my money and using it to benefit me rather then the credit card companies get interest off of my money.
Great post, DD, really generating a lot of comments. I’m actually surprised that most of the comments so far have been against using the free financing.
I can certainly see the argument that Frugal Babe and Discount Knives are making for using such financing. Like I said, I’ve done it in the past. As long as you don’t screw up and it doesn’t cause extra stress for you, I can see why people would want to use it. My guess is, the first time a person messes up and ends up having to pay all the interest that started accruing on day 1 will be the last time that person uses it.
On his website, Ramsey has a statistic that 78% of those free financing deals are not paid off on time. I can’t vouch for the stat but if it’s true, a LOT of people are getting burned doing this.
Great discussion! Mathematically most people forget to factor in risk as part of the equation, so interest free seems like a great deal. Companies offer these things beause they make a ton of money off of them.
You may also want to consider the impact this new credit line would have on your credit score. It might not be an issue for you, but if someone wanted to purchase a home or refinance, a bank could see your new credit line as a potential strike.
I took advantage of a no-interest CC card from Home Depot when we replaced our home windows. It worked for us, as we had budgeted for the windows and still earned interest on our savings account.